The Fed rang an alarm for investors: Equities just got a lot more expensive, so that unless the U.S. stages a quick, extraordinary, V-for-victory recovery, you risk losing lots of money in these frothy markets. The Fed’s being too mild. The raging run-up makes equities way overpriced regardless of the how long the economy takes to rebound.

In its biannual Financial Stability Report published Friday, May 15, the Federal Reserve provided two notes of caution on where asset prices stand now and where they could be headed. The first holds that buying real estate, equities, or other investments on hopes that the pandemic will be short-lived could prove a bad bet. “Asset prices remain vulnerable to significant declines should the pandemic worsen, the economic fallout prove more severe, or financial system strains reemerge,” wrote the central bank’s economists.

The Fed also specifically addressed the dangers posed by the S&P 500’s more than 30% jump since hitting its March lows. “Prices relative to earnings have risen since late March to levels seen before the outbreak,” stated the report. “Prices have increased a fair bit since the trough, and analysts’ firm-level earnings forecasts have fallen in response to the economic deterioration.”

The Fed’s analysis, however, makes it difficult to decipher just how expensive stocks really are. The problem is that the “prices relative to earnings” metric, or the P/E multiple, has two moving parts––prices and profits––so the combination of fast-dropping earnings forecasts and a booming S&P index has sent valuations careening from depths not seen in many years to beyond the heights scaled in late 2019, all in a matter of weeks. In the report, the Fed references data from Refinitiv, the firm that polls buy-side analysts and provides extensive data based on their forecasts. At the close of 2019, the Refinitiv survey predicted that the S&P would post GAAP reported earnings per share of $163 for 2020, for a “forward” P/E of around 19.

Amazingly, when the S&P hit the lows in late March, the analysts, always overly optimistic, were even farther behind than usual: They expected profits to fall just a shade to $160 12 months hence. As a result, the obviously overwrought profit forecast hoisted the denominator, just as the 34% drop in prices was crushing the numerator. The result: a P/E that cratered in late March to 14, a number not witnessed since the Great Recession.

Then both of the moving parts shifted into reverse: Prices soared, and earnings estimates collapsed. In Refinitiv’s most recent report, analysts project profits over the next 12 months of just $129.5, 19% less than the outlook six weeks earlier. The swoon in earnings estimates and explosion in prices has lifted the the P/E cited in the Fed report from 14 to 19, right where it finished in 2019.

It was that roundtrip that spooked the Fed. But wait. The central bank’s numbers are based on prices at the end of April. Since then, the S&P has kept soaring, lifting the forward P/E, as of midday May 18, to 22.8: 20% higher than the end of last year.

Wall Street would argue that the 23-plus reading that looks so outrageously pricey doesn’t tell us much, because it’s based on earnings getting hammered by the sweeping lockdown, and that profits will strongly rebound in the recovery. So where do the pros think earnings will rebound to, and is that estimate reasonable?

A good test is my “Tully 20” rule. It takes the S&P 500 index, the “price,” and divides by a P/E of 20, a multiple that’s well been the average for the past 50 years. Folks buying S&P stocks obviously expect the index to rise from here, so let’s assume that prices rose just a modest 10% in two years, getting us to the second quarter of 2022. In that case, the index would reach 3,250. At a rich, 20 P/E, reported earnings per share would need to be $163 (the price of 3,250 divided by the P/E of 20).

That’s 17% higher than record earnings posted at the end of 2019—and it just won’t happen. America’s big cap companies will not be almost 20% more profitable in mid-2021 than they were in the glory days of 2019. In a best-case outcome, operating margins shrink from their elevated levels of last year to closer to the long-term average of between 8% and 9%. That would put earnings at no more than $130. By the Tully 20 rule, at a 20 P/E a reasonable forecast for the S&P two years from now would be 2,600 (20 multiplied by $130), 12% below where it is today. And given the extreme uncertainty clouding the economy’s future, that’s optimistic.

Speaking of uncertainty, it’s never been harder to predict where profits will be two years from now than it is today. But we do know approximately where they will need to go in order for the S&P to be reasonably priced. It’s anything but. While the reality on the ground is a grim story of crumbling profits, surging joblessness, and Great Depression–style shrinkage in the economy, the markets have entered a parallel universe that might be called fantasyland.